What Is the Spillover Effect and How Does It Affect Economies? (original) (raw)

What Is the Spillover Effect?

Spillover effect refers to the impact that seemingly unrelated events in one nation can have on the economies of other nations. Although there are positive spillover effects, the term is most commonly applied to the negative impact a domestic event has on other parts of the world. Recent examples include natural disasters and stock market crises, amother other macro events.

Key Takeaways

• A spillover effect is when an event in a country has a ripple effect on the economy of another, usually more dependent country.
• Spillover effects can be caused by stock market downturns such as the Great Recession in 2008.
• They can also be caused by macro events like the Fukushima disaster in 2011.
• Some countries experience a cushion from the spillover effect because they are considered "safe haven" economies, where investors park assets when downturns occur.

How the Spillover Effect Works

Spillover effects are a type of network effect that have increased in prevalence due to globalization in trade and stock markets, which deepened financial connections between economies.

The Canada-U.S. trade relationship provides an example of spillover effects. This is because the U.S. is Canada’s main market by a wide margin across nearly every export-oriented sector. The effects of a minor U.S. slowdown are amplified by the Canadian reliance on the U.S. market for its own growth.

For example, if consumer spending in the United States declines, it has spillover effects on the economies that depend on the U.S. as their largest export market. The larger an economy is, the more spillover effects it is likely to produce across the global economy. Since the U.S. is a leader in the global economy, nations and markets can be easily swayed by domestic turmoil.

Most of the world experiences significant spillover effects when there is a downturn or macro effect in the world's two largest economies: the United States and China.

Since 2009, China has emerged as a major source of spillover effects as well. This is because Chinese manufacturers have driven much of the global commodity demand growth since 2000. With China becoming the number two economy in the world after the U.S., the number of countries that experience spillover effects from a Chinese slowdown is increasingly significant.

When China's economy experiences a downturn, it has a palpable impact on the worldwide trade in metals, energy, grains, and many more commodities. This leads to economic pain through much of the world, although it is most acute in Eastern Europe, the Middle East, and Africa, as these areas rely on China for a larger percentage of their revenue.

Special Considerations

Unconnected Economies

There are some countries that experience very few spillover effects in the global market. Such closed-off economies are very rare. For instance, even North Korea⁠—an economy nearly sealed off from world trade in 2024—has begun to feel the⁠ spillover effects from intermittent Chinese slowdowns.

Safe-Haven Economies

No matter how strong, developed countries are still vulnerable to spillover effects, especially stemming from powerful economic phenomena. Japan, the U.S., and the Eurozone, for example, have all experienced spillover effects from China at some point.

When global markets get shaky, investors might shift their investments from one market to another in an effort to insulate from spillover effects. Such a shift may lead to positive boosts in those safe haven markets.

This effect was seen with the U.S. investment inflows during the EU’s struggles with the Greek debt crisis in 2015. When dollars flow into U.S. Treasuries, the yield goes down along with the borrowing cost for American homebuyers, borrowers, and businesses. This is an example of a positive spillover effect from the perspective of a U.S. consumer.

What Is a Spillover Cost in Economics?

Similar to spillover effects are spillover costs, more commonly known as negative externalities. A spillover cost is a cost incurred by any third party outside of a transaction without their agreement or without compensation. Pollution is popularly used to illustrate spillover costs. Take a livestock production facility, for instance. While individuals living in proximity to such a facility may not be participants in the agricultural trade, they may still bear costs associated with it, such as exposure to unpleasant odors or risk of contaminated waterways.

What Causes Spillover Effects?

A wide range of factors and events can lead to spillover effects. In fact, due to global interconnectedness across economies, there are few major phenomena that wouldn't cause spillover effects. Notable sources of spillover effects include economic downturns, supply chain disruptions, geopolitical crises, and natural disasters.

What Is Wage Spillover?

Wage spillover refers to the spillover effects that stem from changes in wages. This could involve anything from increased consumer spending, inflation, fluctuations in employment, and variations in local tax revenue.

The Bottom Line

Spillover effects are indirect economic impacts that countries or regions may experience as a consequence of shifts or events elsewhere. Due to globalization and the interconnectedness of markets, it's rare for any economy to be completely insulated from spillover effects. For the large part, the term is used to refer to negative knock-on impacts, though spillover effects can also be occasionally positive.